General Electric's (NYSE:GE) $16.9 billion bid for the energy assets of French conglomerate Alstom continues to be at the forefront of the company's news. This would be the biggest acquisition in GE's history and would continue driving the company's business emphasis away from GE Capital and its previous financial debacle. While some investors (and seemingly the French government) are opposed to such a big acquisition, here are three reasons it's a good move for GE.
What's in this deal?
First, let's clarify what exactly General Electric wants to buy. GE's bid, if accepted, would cover Alstom's thermal, renewables (power), and grid businesses.
Alstom's power business provides equipment and services for a variety of energy markets, including steam, coal, gas, hydro, nuclear steam, and wind. During Alstom's fiscal 2013, its power business generated $15 billion in sales and $1.4 billion in income from operations.
Alstom's grid business offers transmission and distribution solutions to build out power grids in emerging markets. In fiscal 2013, the grid business produced $5.2 billion in sales and $0.3 billion in income from operations.
What's in this for GE?
One of the biggest drawbacks to large acquisitions is that many companies overpay for the assets. That doesn't appear to be the case here, even with a nearly $17 billion price tag. The transaction is valued at 7.9 times pro forma EBITDA for the 12 months ending September 2013. Also, the actual cost to GE is roughly $13.5 billion because of the cash that stands to be acquired with Alstom's books. GE would pay roughly a 25% premium, which is considerably less than it would shell out if Alstom was in a better position with more leverage.
While this would be the most expensive acquisition in GE's history, investors should keep in mind that the company had $87 billion in consolidated cash at the end of the first quarter, with a majority of that cash held abroad.
Along with being a good value, the potential deal would also boost earnings immediately.
Immediate earnings boost
Some companies must wait years for an acquisition to incrementally add to earnings. That delay is one reason why some companies trend lower when large buyouts are announced. But Alstom's assets would immediately generate incremental profit for GE.
General Electric expects the acquisition to be accretive to earnings in the first year and to add roughly $0.08-$0.10 of earnings per share in 2016. Also, General Electric expects that it would quickly be able to create synergy with the new assets and improve their operating margins from 7% to 10%. Furthermore, GE expects it can generate more than $1.2 billion in cost synergies by year five.
The deal is also is a perfect fit for GE.
"Acquiring Alstom would put an exclamation point on GE's return to deals," said Bernstein analyst Steven Winoker, according to Barron's. "It is among the best fits we have seen with the GE portfolio for some time."
General Electric is continuing to refocus on its industrial business roots, a move that investors have cheered. Power and water contributed 27% of GE's industrial profit in the first quarter and will be one of the company's higher growth and margin segments going forward. Adding Alstom's power and grid assets will fit perfectly within the company's strengths, which is partially why the cost synergies are so appealing.
General Electric CEO Jeff Immelt noted that the company has proven it can create significant shareholder value from its Europe investments. He cited the joint venture with Snecma for aircraft engines, its acquisition of Thomson-CGR for its health-care business, and a previous acquisition from Alstom's gas turbine business, as proof.
GE remains confident that this deal will eventually close despite the French government oppositions to the deal in its current form. Paris appears to favor having Germany's Siemens strike a deal with Alstom that would resemble more of an alliance than an acquisition. This is likely an effort to give Alstom more leverage in an attempt to hike the price that GE will ultimately pay. General Electric said it is willing to work with France's government to help protect jobs and address other concerns. If the deal closes with the current $16.9 billion bid, it should be a good move for GE and its investors.
Daniel Miller has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.